13 Reasons Why – Inflation and the Fed Dilemma

Last night the release of the Fed’s FOMC meeting minutes were generally in line with expectations however the language and actions of the committee is tilting toward the uncertainty around the economic recovery and the prospect of less ‘transitory’ inflation.

In terms the robustness of the recovery, several members emphasised “that uncertainty around the economic outlook was elevated and that it was too early to draw firm conclusions about the paths of the labor market and inflation,”

And on inflation, the number of committee members thinking inflation risks were to the upside went from 5 in May up to 13 of the 18 members in June. From Bloomberg:

“Officials also discussed the rise in inflation, and while they “generally expected inflation to ease” once transitory factors associated with the economy’s rapid reopening had abated, “a substantial majority of participants judged that the risks to their inflation projections were tilted to the upside.”

“Several participants remarked that they anticipated that supply chain limitations and input shortages would put upward pressure on prices into next year,” the minutes said. “Several participants noted that, during the early months of the reopening, uncertainty remained too high to accurately assess how long inflation pressures will be sustained.””

In their latest client update, Crescat Capital (one of the best performing funds) sums up the current macro dilemma we often refer to of the Fed and where gold sits:

“A Tale of Two Destructive Outcomes

The greatest long-term investments are those capable of performing well under opposing inflationary and deflationary economic forces. Today’s abundance of macro, fundamental and technical reasons to be a gold investor have never been greater. The ongoing monetary and fiscal disorder in the global economy underpins the onset of a secular bull market in precious metals.

For us, there is no doubt that the Fed is cornered into choosing between only two destructive outcomes. On one side, it could decide to continue expanding its balance sheet to ensure subdued interest rates at the cost of setting off an inflationary problem. Or, it could take the deflationary route by reversing its unprecedently loose monetary policy, due to overheating economic conditions, resulting in a reckoning moment for financial assets from record valuations.

We weight a much higher probability that the inflationary backdrop will take place in the next few years, accompanied by a low economic growth environment (i.e., a stagflation).”

They later go on to give an excellent summary of the various inflationary forces at play right now and why they are less on the ‘transitory’ side of the inflation debate and more on the ‘sticky’ side.  Here’s 13 reasons why:

  • $3.9 trillion added to the Fed’s balance sheet since January 2020, almost doubling its size.
  • The continuous need by policy makers to suppress interest rates and allow the government to spend WW2 size deficits while accumulating record amounts of debt, now at 140% of GDP.
  • The largest wealth transfer from the government to the people in history, with the net worth for US households, including the bottom 50%, increasing by the largest amount in history.
  • Over 10 years of under investments in natural resource industries creating a long-standing bottleneck in the supply of commodities.
  • Significant amount of money in the sidelines with near $3 trillion of accumulated personal savings, almost twice the size of the prior historical peak.
  • Lack of investments alternatives that yield more than inflation expectations hamstringing investors to seek historically cheap tangible assets, driving commodity prices higher.
  • Helicopter money policies creating severe implications with labour shortages.
  • A clear deglobalization trend developing with worsening US-China relations adding pressure on global logistics.
  • The likely beginning of an upward move in commodities from near historic low price levels.
  • The hesitancy by major energy and metals producers to replenish their reserves through new exploration and development projects creating long-term implications in supply of raw materials.
  • The rise in popularity of the New Green Agenda and ESG principles constraining the exploration and production of certain commodities.
  • The willingness of policy makers to overshoot their inflation goals with extreme stimulative programs now happening worldwide.
  • Companies being pressured to increase wages and salaries to attract workers to return to the labour market.

Unsurprisingly then, gold continued its recent rally on the release of the minutes, holding up above US$1800 despite the higher USD (making it twice as nice in AUD).